GRA 19502
Master Thesis
Component of continuous assessment: Thesis Master of Science
Final master thesis – Counts 80% of total grade
Talking the Talk: An Empirical Investigation into the Economic Effects of Strategy Disclosure
Navn: Alexander Nicolai Askevold Storkaas, Even Andreas Jansson Nilsen
Start: 02.03.2017 09.00
Finish: 01.09.2017 12.00
i Even Andreas Jansson Nilsen
Alexander Nicolai Askevold Storkaas
BI Norwegian Business School - Master Thesis -
Talking the Talk: An Empirical Investigation into the Economic Effects of Strategy Disclosure
Supervisor:
Amir Sasson
Hand-in date:
31.08.2017
Campus:
BI Oslo
Examination code and name:
GRA 19502 Master Thesis
Programme:
Master of Science in Business, Major in Strategy
This thesis is a part of the MSc programme at BI Norwegian Business School. The school takes no responsibility for the methods used, results found and conclusions drawn.
i
ACKNOWLEDGEMENTS ... 1
EXECUTIVE SUMMARY ... 2
INTRODUCTION AND RESEARCH QUESTION... 3
CORPORATE DISCLOSURE AND FINANCIAL PERFORMANCE ... 7
INTRODUCTION TO CORPORATE DISCLOSURE ... 7
MANDATORY DISCLOSURE ... 9
Financial Disclosure and Firm value ... 9
Financial Disclosure and the Equity Cost of Capital ... 10
VOLUNTARY DISCLOSURE: ... 12
Social Disclosure: ... 12
Strategy Disclosure: ... 14
SUMMARY ... 16
HYPOTHESES DEVELOPMENT ... 17
Hypothesis 1: Strategy Disclosure ... 17
Hypothesis 2: Strategic Direction/Goals ... 18
Hypothesis 3: Firm Resources ... 18
Hypothesis 4: Positioning ... 19
Hypothesis 5: Challenges ... 19
RESEARCH DESIGN AND METHODOLOGY ... 20
DATA ... 21
SAMPLE ... 21
EVENT STUDY ... 22
A Brief Introduction: Event Study ... 23
Data:... 24
Expected Returns:... 25
Abnormal Returns: ... 26
Grouping Observations on the Event Date ... 27
STRATEGY DISCLOSURE ... 28
A Brief Introduction: Content Analysis. ... 28
Creating and Testing the Coding Scheme ... 30
Rationale for Scheme Dimensions ... 31
Reliability of Strategy Disclosure Scores ... 36
RESULTS ... 37
Empirical Results ... 37
DISCUSSION ... 50
LIMITATIONS ... 54
IMPLICATIONS AND FURTHER RESEARCH ... 56
CONCLUSION ... 58
APPENDICES ... 59
ii Appendix 1: Rating Scheme for Strategy Disclosure ... 59 Appendix 2: Event Study Results for Top-and Bottom 25% of Strategy Disclosure Scores ... 63 Appendix 3: Abnormal Returns for Top-and Bottom 25% of Strategy Disclosure Scores ... 63
REFERENCES ... 64
1
Acknowledgements
This thesis is submitted to BI Norwegian Business School as the completion of the Master of Science in Business programme, and represents the culminating work of our degree. The paper investigates an infrequently studied part of the strategic management literature, and our contribution to further the understanding of this principally disregarded area of research has been truly rewarding.
We would like to extend our sincerest gratitude to our supervisor, Amir Sasson, for his insightful guidance and constructive feedback throughout the period, as well as his invaluable help in forming our study. Having the opportunity to conduct such research under his supervision is something we will always be grateful for. Further, we would like to thank Nicolai Giil, our research assistant on this paper, for all his help during our study. His exceptional productivity and competence was indispensable for the completion of our data set, and we are convinced he will achieve great things in the future.
We will look back at these two years as a wonderful time in our life, filled with excitement and learning. As a result, further gratitude goes out to all the
professors at BI – you have prepared us wonderfully well for our impending careers, and we are thankful for all your hard work and dedication.
2
Executive Summary
What is the economic value of strategy? Although the extant literature in strategic management has explored many different theories of the firm, the research field has centered on an underlying consensus that strategy is an important driver of corporate performance, and thus holds significant economic value. By extension, if we assume efficient markets, the disclosure of such important information should be reflected in the firm market value. Building on these assumptions, our paper will attempt to identify the economic effects of strategy by examining the impact of strategy disclosure in annual reports on the firm market value.
By performing an event study structured around the release date of corporate annual reports for Norwegian listed firms, this study aims to isolate the financial effects from changes in strategy disclosure quality, represented as the presence of abnormal returns in the event period. To test this relationship, we used a self- constructed score to represent the quality of strategy disclosure by measuring the informational value across several important strategic dimensions presented in the corporate annual reports. Subsequently, we used the disclosure quality of prior years to establish the investor expectations for strategy disclosure, allowing us to investigate the impact of information “shocks” on security price returns.
Our findings show that the disclosure of strategically important information indeed holds economic value, finding significant abnormal returns, and thus increased firm market value, for positive changes in strategy disclosure quality.
Further testing of single dimension effects, however, were less conclusive. This can indicate that, while investors value revelations on corporate strategy overall, disclosure on single dimensions are less valuable due to their potential lack of context. Despite this, our results clearly show that there are substantial economic gains from increasing reporting quality on corporate strategy, encouraging further study of this important, yet partially neglected, area of research.
3
Introduction and Research Question
While a vast number of perspectives have been furthered in the eclectic strategic management literature during the last decades, a common factor has been the importance of strategy as a basis for competitive advantage and, consequently, economic success. While the academic pendulum has swung between internally oriented theories such as the resource-based view (Barney, 1991; Wernerfelt, 1984) and the knowledge-based view (Grant, 1996; McEvily & Chakravarthy, 2002) on one side, and externally focused perspectives such as the industrial organization (Caves & Porter, 1977; Porter, 1981) and the institutional approach (Peng et al., 2009; Scott, 2001) on the other (Hoskisson et al., 1999), the field has seemingly centered around the consensus that strategy is essential for firm
performance (Nag et al., 2007). Assuming this is true, any indications regarding the corporate strategy a firm follows could be considered of high informational value, as its future performance will be contingent on the strategic choices it makes. Thus, the disclosure of strategy would represent important information for company stakeholders, and, in the presence of efficient markets, new revelations would impact the financial performance of the firm (Fama, 1970).
Since the introduction of the efficient market hypothesis (EMH) by Fama (1970), research into the disclosure of corporate information has increased substantially.
Building on the argument of Hayek (1945) that information “…never exists in concentrated or integrated form, but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess,”
(Hayek, 1945, p. 519), Fama (1970) argued that any and all information available will be reflected in the price of a security. Building on this theory, academia purposefully began studying the effects of corporate disclosure and its effects, based on a presupposition that any communication of value-adding information would influence the economic performance of the firm. Thus, as the performance of the firm will be contingent on the strategy it chooses to follow, any revelations related to the corporate strategy would be considered of high informational value for an investor. This paper aims to further the research into strategy disclosure in corporate annual reports, and examine the relationship between the quality of disclosure on different strategic dimensions and financial performance.
4 To test this relationship, we performed an event study around the release date of the annual report, allowing us to isolate any potential abnormal returns induced from positive and negative market surprises with regards to the disclosure of strategy, thus gaining insights into the economic effects of strategy disclosure in annual reports. In order to examine this effect, we used content analysis of firms’
annual reports, and constructed a scheme to rate and classify firms on the quality of their strategy disclosure. This provided us with a specific measurement for the year over year increase or decrease in strategy disclosure, which could be used as an estimate for market surprises. Building on the idea of positive (negative) effects from reduced (increased) information asymmetry, we could test for economic effects from the changes of such disclosure. It is important to note that we do not assess the actual choice of strategy for each individual firm, but rather argue that more detailed strategy disclosure in annual reports will, on average, lead to improved financial performance.
Today, corporate annual reports are considered an important informative tool for investors and other stakeholders, providing factual insights and reducing
information asymmetries between management and other stakeholders. Further, recent legal initiatives have increased the demands facing firms regarding the information disclosed, while the accessibility of annual reports have extended substantially with the technological advances of the last decades. This has led to an important role for disclosure research in the academic literature, as insights into the effects of increased stakeholder communication could potentially have important implications. Despite this, previous academic foci have centered around financial and social disclosure on different firm characteristics, with the strategy equivalent representing only a fraction of this increasing literature
Despite the academically implied importance of strategy revelations in corporate communication, as well as the importance of the EMH, the underwhelming amount of research into the field so far shows a clear gap in the literature. While annual reports contain satisfactory content on the financial, and to a certain extent the social, situation of firms due to legal requirements, corporations do not face the same demands regarding strategic discourse. Instead, insufficient time and corporate resources are allocated to the communication of strategic initiatives in
5 annual reports, while there is an important lack of universality in the reporting practices (Dhaliwal et al., 2011). This disregard for the disclosure of strategy has paradoxically been present in the research literature as well, even though early disclosure literature indicated an important relationship (Bowman & Haire, 1975;
Ullmann, 1985). Instead, emphasis laid with the economic effects of financial and social reporting, ignoring the potential impact from corporate disclosure on strategic dimensions (Abrahamson & Amir, 1996). Since such revelations
represent potentially important information for stakeholders and investors, as well as significant economic effects, forming an understanding of the impact of
strategy disclosure is necessary both to further the academic literature and to improve reporting practices. The authors of this paper will, humbly, aim to fill parts of this gap in the academic sphere through our analysis, attempting to shed light on an insufficiently researched field. This leads us to the research question guiding our study:
“To what extent does strategy disclosure impact firm market value?”
In order to test the economic effects of changes in the disclosure quality from one year to the next, we performed an event study – a study examining the abnormal returns for an individual security in a period surrounding a corporate event. Here we computed the expected return of each firm for a ±10-day period around the release date of the annual report for the years 2011-2015, allowing us to
investigate whether an individual firm experienced abnormal returns in the event period. To estimate the disclosure quality for each firm-year, we used content analysis methodology. Specifically, we constructed a scheme to represent the quality of strategy disclosure in annual reports for listed firms on Oslo Stock Exchange for the period 2011-2015, rating each report on 14 different strategic disclosure dimensions argued to be value-adding information related to the corporate strategy. The individual dimension scores were then aggregated to form the total score strategy disclosure for all 490 firm-years in our sample. The ratings from our scheme were subsequently used to categorize the firms into groups of positive and negative information “shocks”, using the average strategy disclosure scores for prior years obtained for each firm as a proxy for investor expectations for the years 2014 and 2015. Further, we tested the relationship between
increasing disclosure quality and abnormal returns for the single dimensions
6 argued to be most important for the investor, using the same methodology as for the overarching construct. By examining these changes in disclosure quality, we can enquire into the financial effects of strategy disclosure on firm market value.
We find strong support for a positive relationship between increased strategy disclosure quality and increase in firm market value, represented by the presence of cumulative average abnormal returns (CAAR) in the event period. We do not, however, find support for our hypothesis regarding the relationship between negative changes in the disclosure quality and negative impact on firm market value. This is perhaps not surprising, as negative disclosure quality does not necessarily equal reduced information in the market. While increased disclosure quality is a result of new information, its negative counterpart does not remove information in the market. Instead, while this information is not disclosed explicitly for a given year, it still exists in the market due to disclosure over preceding years. In explaining the strong positive results, we also tested all the single dimensions. Annual reports are without doubt quite similar from year to year, and the lack of variation along single dimensions was therefore an issue in trying to explain what dimensions were responsible for the abnormal returns we found on the disclosure score. We therefore found little empirical support for the influence of single dimensions. It is, however, important to emphasize that our scheme was conceptualized based on an idea of an overarching measure for strategy disclosure, and the main focus is thus not on the individual dimensions that may drive abnormal returns.
This study contributes to the literature on both corporate disclosure and the value of strategy, the importance of different strategic dimensions in corporate reporting as represented in our scheme, as well as the accounting practices related to
disclosure on corporate strategy in annual reports. As the existing literature on voluntary disclosure has yet to reach unanimity regarding the economic effects of increased disclosure, our study contributes in several respects. First, in analyzing abnormal returns in the presence of information “shocks”, we show that the market value of the firm is affected by the quality of strategy disclosure provided in annual reports. This further confirms the economic value of corporate strategy, as well as providing additional understanding of the financial effects of reduced information asymmetry through higher disclosure quality. Second, our scheme
7 includes important strategic dimensions based on existing literature on corporate strategy. Although not exhaustive, this list proposes a set of elements within strategy communication to be further explored in research to achieve a better understanding of the disclosure of strategy in corporate annual reports. Finally, the results of our study provide contributions to both managerial and accounting practices. In showing the actual economic value of increased strategy disclosure, managers will potentially be incentivized to expand their effort on strategy reporting in corporate communication, while accounting practices may gradually implement a more dedicated effort in highlighting the role of strategy in annual reports. Ultimately, the findings presented in this paper can have implications on several arenas.
The remainder of the paper is structured as follows. We begin by reviewing the relevant literature on corporate disclosure, at both the mandatory and voluntary level, and its effects on different financial dimensions of the firm. Next, we use the findings from the literature review to construct our hypotheses. After this, we describe the extensive methodological approach that forms the basis of our paper, introducing first our event study that examines the economic impact of strategy disclosure, and afterwards our content analysis of corporate annual reports that lead to our independent variable. We then put forward the empirical results from the study and our associated discussion, before providing an overview of the limitations of our study and implications for both research and practice. Finally, we present our conclusion.
Corporate Disclosure and Financial Performance
Introduction to Corporate Disclosure
According to the efficient market hypothesis (EMH) (Fama, 1970), any stock will be trading at its fair value, thus reflecting all the available information dispersed in the market (Hayek, 1945). As a result, the academic literature has gradually increased its focus towards corporate disclosure – both mandatory and voluntary – and its effects on the company (Richardson & Welker, 2001). This builds on information asymmetry, and the argument that managerial knowledge regarding company matters surpass that of the information available to the investors (Healy
8
& Palepu, 2001), which has subsequently led to an increase in mandatory disclosure in recent years, such as e.g. the Sarbanes Oxley Act. Despite these positive developments, the increased regulatory demands mainly concern financial and accounting reporting, partially neglecting the qualitative parts of corporate reporting (Santema & Van de Rijt, 2001). Even as companies must conform to certain regulatory constraints and demands regarding content, some go beyond the legal imperative. This voluntary disclosure – defined as that in excess of the required – has thus become the subject of intensive research, building on the premise of its informative value (Meek et al., 1995). Research within different spheres of the disclosure literature have indicated a positive relationship between the extent of disclosure and economic performance, such as lower cost of capital due to less information risk (Botosan, 1997; Lambert et al., 2007). This, alongside a more accurate valuation of firm value through better information (Botosan, 2006), could provide managers with incentives to voluntarily disclose corporate matters, even outside the regulatory boundaries. Thus, recent years have seen a substantial increase in the research into corporate disclosure, with the main empirical body centering around the annual report (Yuthas et al., 2002).
Annual Reports are considered a prime tool for investor decision making (Benartzi & Thaler, 1993) and companies can use it strategically as a
communication medium for different stakeholders (Stanton & Stanton, 2002). It allows a company to proactively paint an external picture of its own existence, with (Hines, 1988) arguing that in “…communicating reality, you construct reality,”(Hines, 1988, p. 257). While the ostensible content may conceivably hold little resemblance to the de facto state of a given firm, annual reports are regarded as a powerful source of information regarding company matters (Diamond &
Verrecchia, 1991). Botosan (1997) further argues that the corporate annual report of each individual firm serves as a good proxy for its general level of disclosure across mediums, as the disclosure levels in annual reports have been found to be highly correlated with other forms of disclosure for the same firm (M. Lang &
Lundholm, 1993). Considering this, annual reports have in recent decades formed the basis for disclosure research at both the mandatory and voluntary level in the academic sphere (Ahmed & Courtis, 1999; Yuthas et al., 2002).
9 Mandatory Disclosure
As the legal requirements on corporate reporting has increased in recent years, research on its effects on the financial performance has increased. Though financial regulation imposes a substantial and increasing amount of mandatory disclosure through a variety of regulated financial reports, firms appear to voluntarily provide the capital market with additional information. Lang and Lundholm (1996) show that firms with more informative disclosure policies face lower volatility in analyst forecast revision, less dispersion among individual analyst forecasts, and more accurate earnings forecasts. Combined, these factors reduce the information asymmetry between the firm and investors, which in recent decades has been shown to affect firm value. (e.g. Baiman & Verrecchia, 1996;
Botosan, 1997; Diamond & Verrecchia, 1991; Graham et al., 2005; Plumlee et al., 2008; Richardson & Welker, 2001).
Financial Disclosure and Firm value
Information asymmetries are argued to reduce firm value, in that they introduce adverse selection into transactions between buyers and sellers of firm shares (Leuz & Verrecchia, 2000). Adverse selection is typically manifested in reduced share liquidity and higher bid-ask spreads, as observed by Copeland and Galai (1983). To overcome the effect of information asymmetries, firms must issue capital at a discount, and this discount represents a higher cost of capital to the firm (Leuz & Verrecchia, 2000). Disclosure reduces the possibility of information asymmetries arising between market participants, as well as the market and the firm itself, and, disclosure should therefore reduce the discount at which firm shares are sold and increase firm value (Hope, 2003; M. H. Lang & Lundholm, 1996; Prencipe, 2004).
Following the same line of reasoning, Einhorn (2005) shows this concept in a more elegant equilibrium model, proposing that rational and risk-neutral investors stipulate their value of a firm based on all available information. Hence, for any given corporation, higher disclosure will, ceteris paribus, lead to a higher valuation. According to Foster (2003, p. 1), former member of the Financial Accounting Standards Board (FASB), “…more information always equates to less uncertainty, and people pay more for certainty,”.
10 To illustrate the aforementioned idea in a simple example, one can consider the case where two firms, firm A and B, have the same expected payoff, but differ in terms of disclosure. Firm A has a high disclosure, giving investors confidence about the firms’ future payoff, while, in contrast, firm B does not disclose much information to the market. As a result, investors are, on average, more uncertain about their predictions about future earnings. The CAPM treats the expected payoff for both firms as if “true” and ignores the investors differential uncertainty with regards to their predictions (Botosan, 2006). Consequently, the CAPM does not account for the role of investors uncertainty in determining the optimal portfolio choice, or the equilibrium pricing (Botosan, 2006). In sharp contrast, Easley and O'hara (2004) show that in equilibrium, stocks with higher estimation risk, ceteris paribus, obtain a lower pricing.
Financial Disclosure and the Equity Cost of Capital
The relation between accounting information and the cost of capital is one of the most fundamental issues in the accounting literature (Lambert et al., 2007). Levitt (1998), former chairman of the SEC suggests that; “…high quality accounting standards… reduces capital costs,” (Levitt, 1998, p. 81). This, along with
increasing regulatory demands of transparent reporting, has led to research on the relationship between financial disclosure and subsequent performance. Although the reasoning is intuitive, the theoretical work on the hypothesized link is
somewhat limited. Theoretical research supporting a negative association between disclosure and equity cost of capital has historically followed two related ideas.
The first stream of research proposes that greater disclosure enhances stock market liquidity, either through lower transaction costs or an increased demand for a firm´s security, which implies a lower equity cost of capital (Botosan, 1997).
The second stream of research suggests that greater disclosure reduces the information asymmetry, thereby reducing the estimation risk arising from investors estimates of the payoff distribution of the stock.
Amihud and Mendelson (1986) argue that cost of equity capital is higher for stocks with large bid/ask spreads, which is consistent with Demsetz (1968), Copeland and Galai (1983), and Glosten and Milgrom (1985). Amihud and
11 Mendelson (1986) are amongst the first advising managers to disclose private knowledge, in order to reduce bid/ask spreads and cost of equity capital (Botosan, 2006).
Central to the core of this literature is the relationship between private and public information, and that public disclosure reduces information asymmetry by displacing private information. Some papers address this explicitly (i.e. Easley &
O'hara, 2004) and show that differences in the composition of information between public and private information affect the cost of capital, Despite this, Botosan´s (2006) review of the literature notes that “…neither theory nor extant empirical evidence unambiguously supports this assumption,”(Botosan, 2006, p.
34).
Further, several early studies on this focus on the relationship between estimation risk and the cost of equity capital, including Barry and Brown (1985), Coles and Loewenstein (1988), Handa and Linn (1993), Coles et al. (1995) and Clarkson (1996), who all provide some supporting evidence for the theory. However, much of the early literature into the area suffers under the lack of construct validity for the cost of equity capital measures, making the research inadequate to prove sound empirical evidence for the hypothesized link (Botosan, 2006). More recent work by Lambert et al. (2007) try to fill this gap by using more valid measures of equity cost of capital. Through developing an asset-pricing model in which both public and private information affect asset returns, they find support for the negative relation between disclosure and cost of equity capital. More specifically, the core issue is to show that firm disclosures reduce the non-diversifiable risks in economies with multiple securities, withstanding the forces of diversification.
Through building an asset pricing model consistent with the CAPM (Fama &
Miller, 1972), Lambert et al. (2007) show two effects of disclosure on the cost of capital; directly and indirectly. The direct effect stems from the disclosure effect on the firms´ assessed covariance with other firms expected cash flows, which is non-diversifiable. In other words, higher quality disclosure does not affect the cash flows per se, but affect the market participants ex-ante expected cash flows.
The second effect, namely the indirect effect, shows the impact on the cost of capital through its effect on real decisions that impact the future cashflows and covariances of cashflows.
12 As shown by the existing literature on financial disclosure, increased disclosure quality can have positive financial effects for the company. This is in line with the argument that reduced information asymmetry can increase the performance of the firm, meaning that it is plausible to assume that increased information of a voluntary nature may also have significant economic impact.
Voluntary Disclosure:
The notion that any reduction in information asymmetry between managers and external stakeholders creates firm value has further led to an increase in disclosure of a voluntary nature, building on the premise of its informational value. Contrary to the financial equivalents, these voluntary disclosures do not conform to strict regulations and is thus not represented comparably across actors, but rather selectively based on individual firm preferences (Dhaliwal et al., 2011; Ingram, 1978). Thus, a prevalent issue with any form of disclosure not bound by
legislation is the lack of universal practice of its reporting, limiting the ability to consistently evaluate the quality across industries and firms (Abbott & Monsen, 1979; Gray et al., 1995). Despite this, attempts have been made at examining the effect of voluntary disclosure of different forms, with perhaps the main emphasis being on corporate social reporting (Neu et al., 1998; Richardson & Welker, 2001;
Ullmann, 1985), while corporate strategy disclosure represents a less evolved academic stream (Abrahamson & Amir, 1996; Padia & Yasseen, 2011; Santema et al., 2005).
Social Disclosure:
Despite occupying a substantial role in accounting research during the last decades, academia has not reached consensus regarding the effects of corporate social reporting (CSR) and social disclosure (Gray et al., 1995; Ullmann, 1985), broadly defined as the revelation of social commitments and engagements of the firm. Further, the lack of a unifying and focused definition of social disclosure across studies has served as a barrier to achieve coherence in results (Ingram, 1978; Richardson & Welker, 2001).
13 Ullmann (1985) provides an extensive review of the relationship between social disclosure and economic performance, showing that the academic consensus builds on the premise of the EMH; corporate social disclosure, in containing value-relevant information, will be reflected in the share price and thus show the fair value of the company. It is argued that voluntary disclosure related to societal activities contains significant informational value for the investor and other stakeholders, and so should its inclusion should contribute to the economic performance of the firm (Dhaliwal et al., 2011; Graham et al., 2005). Following this line of reasoning, the effects of social disclosure on economic performance has been argued to be comparable to that of its financial counterpart, as all information related to social disclosure will serve to reduce the information
asymmetry between the two parties. The findings regarding the causal relationship between social disclosure and economic performance, however, are widely
dispersed and, as a result, highly debated (Patten, 1992; Richardson & Welker, 2001; Ullmann, 1985).
Among the early works, Belkaoui (1976) found support for an ethical investor hypothesis, arguing that the disclosure of socially grounded information positively impacted the financial performance of the firm. He investigated the effect of pollution disclosure in annual reports, indicating a temporary positive net effects arising from increased disclosure (Belkaoui, 1976). The findings, however, were later criticized for being misinterpreted. Frankle and Anderson (1978) argued instead that non-disclosing firms outperformed the market, before later confirming the initial positive relationship between social disclosure and firm performance, albeit only for certain periods (Anderson & Frankle, 1980). Per contra, both Ingram (1978) and Abbott and Monsen (1979), found there to be no significant relationship between the extent of disclosure and different market variables, while Ingram and Frazier (1983) proposed a weak negative correlation between social disclosure and accounting ratios, emphasizing that the findings, and the
relationship in general, is contingent on a wide variety of variables.
Another branch in the literature has focused on the effects from social disclosure on a company’s social performance, and the subsequent effect from the latter on financial performance, but even here results are dispersed (Griffin & Mahon, 1997). This relationship is complex, as the causal relationship between the social
14 disclosure of the firm and its economic performance is further complicated by the potential meditational effect of its social performance, making it hard to
distinguish singular effects. Even if these disclosure effects could be demarcated from the impact of social performance, the natural presupposition that a positive correlation between social disclosure and social performance exists has yet to be consistently proven (Ullmann, 1985).
Although the research on the financial effects of social disclosure has not yet found consensus, several studies indicate that there exists a relationship between disclosure at the voluntary level and economic factors. These indications provide incentives to further examine the potential financial effects from voluntary revelations, and recommendations from Ullmann (1985) and Bowman and Haire (1975) to further understand the role of strategy in social disclosure testify to the potentially important role of voluntary disclosure in general.
Strategy Disclosure:
In recommending a future direction to converge toward consensus regarding the effects of social disclosure on the economic performance of firms, Ullmann (1985) argued that an important omitted variable to consider was that of strategy.
This argument was built on the notion that any impact will be dependent on the stakeholder strategy employed, which was first introduced by Bowman and Haire (1975). In subsequent works, however, Bowman (1976, 1978, 1984) focused on the content of the narrative part of corporate annual reports, arguing that the scrutiny of these could provide insights into the effectiveness of a company’s strategy. Through careful content analysis, Bowman deducted behavioral
differences between well-performing firms and their underachieving equivalents, indicating the informative value of annual reports as an important tool for
investors and stakeholders alike (Kohut & Segars, 1992). While not examining any causal relationship between the disclosure and performance in his work, Bowman employed a line-by-line comparison of report content for different firms, building on the idea of strategy disclosure as something of informational value.
15 Despite these early works, strategy disclosure, defined as “…the revelation of information an organization decides to share with its stakeholders on the strategy it is pursuing and going to pursue in the future,” (Santema et al., 2005, p. 354), has since remained a seldom researched area in the literature. As most academic focus is guided to disclosures regarding accounting and corporate social
responsibility, little attention has been given to the strategic revelations found in corporate annual reports or other informational mediums (Abrahamson & Amir, 1996; Santema et al., 2005; Yuthas et al., 2002). However, Bartlett and Chandler (1997) and D. Barry and Elmes (1997) underlines its integral role for shareholders and investors, while increased disclosure regarding strategic initiatives is
recommended by auditors (Ernst & Young, 2008; KPMG, 2014) and financial service firms (Standard & Poor’s, 2002) worldwide.
Higgins and Bannister (1992) argued that strategic credibility, partly achieved through revelations in annual reports, affected a company’s share price, encouraging further research into corporate communication on strategy, while Kohut and Segars (1992) argued that it could be an important tool to distinguish oneself from the competition, stating that through effective communication in annual reports “… a company earns credibility by convincing others that it is pursuing a sound strategy and has an effective planning capability,” (Kohut &
Segars, 1992, pp. 7-8). Barron et al. (1999) found that higher Management Discussion & Analysis (MD&A) ratings in annual reports, taken from the SEC, were negatively correlated with the accuracy of earnings forecast by analysts, with regression estimates showing that a one standard deviation increase in MD&A quality lead to a 24 and 13 percent decrease in dispersion and error in earnings forecasts, respectively (Barron et al., 1999).
In more recent work, research into strategy disclosure in annual reports of Dutch firms (Santema & Van de Rijt, 2001) and, by extension, firms across Europe (Santema et al., 2005) found that firms in general disclose relatively little
regarding strategy, as opposed to finance/accounting, while also showing that the amount of disclosure differ across countries (Santema et al., 2005). Further, Padia and Yasseen (2011), examining only the extent of strategy disclosure, showed that although South African listed companies generally disclosed more information
16 regarding corporate strategy than their European counterparts (Santema et al., 2005), only 6% of the investigated sample made maximum disclosure.
Although academic insights have suggested positive effects of increasing levels of strategy disclosure through a diminution in information asymmetry, research in the area remain limited. Additionally, most studies have either examined descriptive statistics regarding strategy disclosure or correlation with different firm characteristics, as no study has yet, to the best of these authors’ knowledge, explored causal relationships between strategy disclosure and financial
performance, presenting an important area for further research.
Summary
The academic literature has thus examined many different facets within corporate disclosure, with perhaps the single unifying element across the research on being the idea that disclosure is a partial solution to the information problem investors face, and that a subsequent reduction in information asymmetry between
companies and investors will have a positive effect on financial performance.
Although widely recognized at the conceptual level, the empirically established relationship between voluntary disclosure and financial performance can be considered ambiguous, at best. Ultimately, the lack of coherent results, especially with regards to information of a voluntary nature, has largely been credited to the conceptual variety in the aforementioned studies (Richardson et al., 1999;
Ullmann, 1985). The inherent noncomparability of voluntary disclosure is also a pertinent issue with regards to coherence (Dhaliwal et al., 2011), as the
“…absence of common structures and characteristics…” (Kohut & Segars, 1992, p. 8) makes it difficult to generalize findings.
Despite the aforementioned limitations regarding the study of corporate disclosure, the indications from previous research implies an existing causal relationship between the information disclosed and different dimensions of firm value. As such, it is important not to neglect this area of research simply due to methodological difficulties, but rather stay determined in the pursuit of coherence.
Our study contributes to the research on voluntary disclosure and the role of decreased information asymmetries and its economic effects. The findings
17 presented in this paper will provide a deeper understanding of the role of
disclosure and, more specifically, the impact of strategy disclosure on the market value of firms. This leads us to the hypotheses guiding our study.
Hypotheses Development
Hayek (1945) argued that self-interested traders are motivated to acquire and trade on their private information. In doing so, they create increasingly efficient market prices, which in the competitive limit reflect all available information, implicating that stock prices can only move in response to news. This conceptual work
preceded Fama´s (1970) empirical examination of the subject, which eventually led to the efficient market hypothesis (EMH).
Following the reasoning of the efficient market hypothesis, we argue that the manifestation of abnormal returns is likely to occur in instances where the market observes a significant change in the disclosure level. Our scheme treats the annual report of each individual firm i for time t independently, so subsequently a firm following the same exact level of disclosure year after year would score the same.
Our scheme, on the other hand, captures strategy related information that is forward looking, and often similar from year to year. With the EMH in mind, testing levels of disclosure independently from year to year makes very little sense. Therefore, relative changes in disclosure level constitute new information in the market, and, considering the annual report´s value as a good proxy for disclosure level (Botosan, 2006), relative changes in the annual report implies relative changes in disclosure level.
Hypothesis 1: Strategy Disclosure
Assuming equal weight of our dimensions, the total score, which indicates a summed score across 14 dimensions of disclosure well defined within strategic management literature, is a proxy for the general disclosure level of the firm. The strategy disclosure score will represent an overarching measure of the quality of disclosure for each firm for a given year, and thus, assuming EMH holds, we expect that positive information “shocks” in the market will have an impact on the firm market value, represented as the presence of positive CAAR. We expect the
18 opposite to happen for decreased disclosure quality, as this introduces uncertainty in the market through an increase in information asymmetry.
𝐻1𝑎 = 𝑃𝑜𝑠𝑖𝑡𝑖𝑣𝑒 𝑐ℎ𝑎𝑛𝑔𝑒𝑠 𝑖𝑛 𝑞𝑢𝑎𝑙𝑖𝑡𝑦 𝑜𝑓 𝑠𝑡𝑟𝑎𝑡𝑒𝑔𝑦 𝑑𝑖𝑠𝑐𝑙𝑜𝑠𝑢𝑟𝑒 𝑦𝑖𝑒𝑙𝑑 𝑝𝑜𝑠𝑖𝑡𝑖𝑣𝑒 𝐶𝐴𝐴𝑅 𝐻1𝑏= 𝑁𝑒𝑔𝑎𝑡𝑖𝑣𝑒 𝑐ℎ𝑎𝑛𝑔𝑒𝑠 𝑖𝑛 𝑞𝑢𝑎𝑙𝑖𝑡𝑦 𝑜𝑓 𝑠𝑡𝑟𝑎𝑡𝑒𝑔𝑦 𝑑𝑖𝑠𝑐𝑙𝑜𝑠𝑢𝑟𝑒 𝑦𝑖𝑒𝑙𝑑 𝑛𝑒𝑔𝑎𝑡𝑖𝑣𝑒 𝐶𝐴𝐴𝑅
Hypothesis 2: Strategic Direction/Goals
Where does the company want to go, and how does it get there? Firm strategy is a matter of the owners of the firm. However, the board usually handle the practical sides of the strategic activity. For the investors, the annual report is therefore an important tool to control that the board and management is following up on the set strategy. Whilst the general assembly agree upon the overall direction, the board and management usually stake out the answer to how it should reach their goals.
Strategy has important implications to the future economic performance of a firm, and it is therefore of great interest for the investors to get an insight into the firm´s decisions. Accordingly, we hypothesize that positive changes in the disclosure quality along these dimensions will give positive CAAR, due to a reduction in information asymmetry. We expect the opposite to happen for decreased disclosure, as it would introduce uncertainty in the market.
𝐻2𝑎= 𝑃𝑜𝑠𝑖𝑡𝑖𝑣𝑒 𝑐ℎ𝑎𝑛𝑔𝑒𝑠 𝑖𝑛 𝑑𝑖𝑠𝑐𝑙𝑜𝑠𝑢𝑟𝑒 𝑜𝑓 𝑓𝑖𝑟𝑚 𝑠𝑡𝑟𝑎𝑡𝑒𝑔𝑖𝑐 𝑑𝑖𝑟𝑒𝑐𝑡𝑖𝑜𝑛 𝑎𝑛𝑑 𝑔𝑜𝑎𝑙𝑠 𝑦𝑖𝑒𝑙𝑑 𝑝𝑜𝑠𝑖𝑡𝑖𝑣𝑒 𝐶𝐴𝐴𝑅
𝐻2𝑏= 𝑁𝑒𝑔𝑎𝑡𝑖𝑣𝑒 𝑐ℎ𝑎𝑛𝑔𝑒𝑠 𝑖𝑛 𝑑𝑖𝑠𝑐𝑙𝑜𝑠𝑢𝑟𝑒 𝑜𝑓 𝑓𝑖𝑟𝑚 𝑠𝑡𝑟𝑎𝑡𝑒𝑔𝑖𝑐 𝑑𝑖𝑟𝑒𝑐𝑡𝑖𝑜𝑛 𝑎𝑛𝑑 𝑔𝑜𝑎𝑙𝑠 𝑦𝑖𝑒𝑙𝑑 𝑛𝑒𝑔𝑎𝑡𝑖𝑣𝑒 𝐶𝐴𝐴𝑅
Hypothesis 3: Firm Resources
According to Wernerfelt (1984) and Barney (1991), the basis for competitive advantage stems from the firm-specific resources that are not easily imitable by competitors. Thus, we hypothesize that investors are interested in the firm specific resources possessed by the firm, and the current and planned allocation of these.
Since these resources are important for the sustained competitive advantage of the firm, positive changes in the disclosure level of a firm along this dimension
19 should give positive CAAR. We expect the opposite to happen for decreased disclosure, as it would introduce uncertainty in the market.
𝐻3𝑎= 𝑃𝑜𝑠𝑖𝑡𝑖𝑣𝑒 𝑐ℎ𝑎𝑛𝑔𝑒𝑠 𝑖𝑛 𝑑𝑖𝑠𝑐𝑙𝑜𝑠𝑢𝑟𝑒 𝑜𝑓 𝑓𝑖𝑟𝑚 𝑟𝑒𝑠𝑜𝑢𝑟𝑐𝑒𝑠 𝑦𝑖𝑒𝑙𝑑 𝑝𝑜𝑠𝑖𝑡𝑖𝑣𝑒 𝐶𝐴𝐴𝑅 𝐻3𝑏= 𝑁𝑒𝑔𝑎𝑡𝑖𝑣𝑒 𝑐ℎ𝑎𝑛𝑔𝑒𝑠 𝑖𝑛 𝑑𝑖𝑠𝑐𝑙𝑜𝑠𝑢𝑟𝑒 𝑜𝑓 𝑓𝑖𝑟𝑚 𝑟𝑒𝑠𝑜𝑢𝑟𝑐𝑒𝑠 𝑦𝑖𝑒𝑙𝑑 𝑛𝑒𝑔𝑎𝑡𝑖𝑣𝑒 𝐶𝐴𝐴𝑅
Hypothesis 4: Positioning
Porter (1980) argued that the strategic positioning of a firm was essential to competitive advantage and sustained success. It will be important for potential investors to understand how a company differs from other competing actors, as it gives indications to the future of the industry. Thus, we expect positive changes in the disclosure level of a firm along this dimension to give positive CAAR. We expect the opposite to happen for decreased disclosure, as it would introduce uncertainty in the market.
𝐻4𝑎= 𝑃𝑜𝑠𝑖𝑡𝑖𝑣𝑒 𝑐ℎ𝑎𝑛𝑔𝑒𝑠 𝑖𝑛 𝑑𝑖𝑠𝑐𝑙𝑜𝑠𝑢𝑟𝑒 𝑜𝑓 𝑓𝑖𝑟𝑚 𝑝𝑜𝑠𝑖𝑡𝑖𝑜𝑛𝑖𝑛𝑔 𝑦𝑖𝑒𝑙𝑑 𝑝𝑜𝑠𝑖𝑡𝑖𝑣𝑒 𝐶𝐴𝐴𝑅 𝐻4𝑏 = 𝑁𝑒𝑔𝑎𝑡𝑖𝑣𝑒 𝑐ℎ𝑎𝑛𝑔𝑒𝑠 𝑖𝑛 𝑑𝑖𝑠𝑐𝑙𝑜𝑠𝑢𝑟𝑒 𝑜𝑓 𝑓𝑖𝑟𝑚 𝑝𝑜𝑠𝑖𝑡𝑖𝑜𝑛𝑖𝑛𝑔 𝑦𝑖𝑒𝑙𝑑 𝑛𝑒𝑔𝑎𝑡𝑖𝑣𝑒 𝐶𝐴𝐴𝑅
Hypothesis 5: Challenges
The issues that the company is faced with is important for the investor to understand. Even more so, it is important that the company has clear ideas on mitigating measures for the potential challenges. Challenges may act as an impediment to successful implementation of firm strategy (Hrebiniak, 2006), and it is accordingly of high value to the investor to get insight into the companies’
perceived challenges and its proposed mitigating measures. Considering this, we expect positive changes in the disclosure level of a firm along this dimension to give positive CAAR. We expect the opposite to happen for decreased disclosure, as it would introduce uncertainty in the market.
𝐻5𝑎= 𝑃𝑜𝑠𝑖𝑡𝑖𝑣𝑒 𝑐ℎ𝑎𝑛𝑔𝑒𝑠 𝑖𝑛 𝑑𝑖𝑠𝑐𝑙𝑜𝑠𝑢𝑟𝑒 𝑜𝑓 𝑓𝑖𝑟𝑚 𝑐ℎ𝑎𝑙𝑙𝑒𝑛𝑔𝑒𝑠 𝑦𝑖𝑒𝑙𝑑 𝑝𝑜𝑠𝑖𝑡𝑖𝑣𝑒 𝐶𝐴𝐴𝑅 𝐻5𝑏 = 𝑁𝑒𝑔𝑎𝑡𝑖𝑣𝑒 𝑐ℎ𝑎𝑛𝑔𝑒𝑠 𝑖𝑛 𝑑𝑖𝑠𝑐𝑙𝑜𝑠𝑢𝑟𝑒 𝑜𝑓 𝑓𝑖𝑟𝑚 𝑐ℎ𝑎𝑙𝑙𝑒𝑛𝑔𝑒𝑠 𝑦𝑖𝑒𝑙𝑑 𝑛𝑒𝑔𝑎𝑡𝑖𝑣𝑒 𝐶𝐴𝐴𝑅
20
Research Design and Methodology
This study will attempt to estimate the relationship between the strategy
disclosure score from firms’ annual reports and subsequent economic effects. To do this, a comprehensive methodology is needed.
First, we want to associate the year over year changes in disclosure for each firm with a financial impact, to show the economic effects of strategy disclosure. As the EMH argues that such information will be immediately reflected in the share price, event studies have become a common tool for investigating security price reactions to new market information (Binder, 1998; Eckbo, 2008). Using an event period structured around the release date of the individual annual reports, we can isolate the financial impact of new information by identifying the potential presence of abnormal returns in the event period. Although the event study methodology has not, to the best of our knowledge, been used previously in disclosure research, we argue that it is appropriate in this paper due to our examination of the economic effects of changes in strategy disclosure.
Second, to associate the abnormal returns with changes in disclosure, the annual reports must be read and the variable strategy disclosure constructed, as there is no standard measurement for this available. Due to the qualitative nature of voluntary communication in annual reports, content analysis has become a widely applied methodology to assess the actual quality of the disclosure (Beattie et al., 2004). This follows the existing literature in strategy disclosure (Bowman, 1976, 1978, 1984; Padia & Yasseen, 2011; Santema et al., 2005; Santema & Van de Rijt, 2001), as this methodological approach is considered one of the most powerful tools for analyzing texts and documents (Bryman & Bell, 2015).
Although the disclosure literature has employed both self-constructed scores and archival metrics to measure disclosure level, the research on strategy disclosure has exclusively used the former due to the lack of availability of the latter. Thus, our scheme consists of a qualitative rating on 14 dimensions of strategy found in the textual part of the annual report for 490 firm-year observations.
21 Data
Our study will use a sample consisting of public firms listed on the Oslo Stock Exchange (OSE) for the period 2011-2015. OSE is a stock exchange with a high density of firms within the energy sector, and, as of January 2017, firms within the energy industry makes up 35% of the combined market value. The average market size of the 187 listed firms is 11 581 MNOK, with a standard deviation of 44 483 MNOK, and a market value median of 1 896 MNOK.
Following the decline in oil prices in later years, the energy sector is currently going through a phase of downsizing, cost-cuts and repositioning. Although there has been a significant decrease in the market value of many of the energy related stocks, other parts of the economy have thrived. Especially the seafood industry, and other export focused industries have done well. In the case of seafood, very favorable market conditions, and a positive weakening of the Norwegian krone has contributed to record earnings throughout the industry.
Sample
For our scheme, we used all listed firms except listed savings banks,
conglomerates, and firms that have not been noted for the whole period of our analysis. Savings banks have been eliminated due to the fact that they issue equity certificates, that differ from stocks when it comes to influence over the bank´s governing bodies1. For that reason, we found them unfit for looking at disclosure in our context, since the certificate holders have only a limited voice and therefore less incentives to monitor the firm. Conglomerates were removed due to their rather different strategy disclosure report format, as they mainly focus on strategy at the business level as opposed to the corporate level. Since our scheme was developed for scoring corporate strategies, it was difficult to apply the same method to score conglomerates with vastly different strategies for different subsidiaries. Firms that have not been noted for the whole period was also removed, since many of them lacked a complete record of annual reports which was needed to set an expectation for the disclosure level in our analysis. For the same reason, we removed some firms that had been listed throughout the whole
1 http://www.sparebankforeningen.no/en/egenkapitalbevis/about-equity- certificates/
22 period, but did not have all the reports available online. In these few instances, we sent emails to the respective investor relations office, requesting the annual report, but received no answer.
After this process, our number of firms was reduced to 98, giving N = 490 when considering 5 firm-years. In the case where a firm has been read multiple times by coders for reliability and stability tests, the included scoring has been drawn randomly between the different coders, so that it is only included once in our dataset.
Figure 1: Total Market Value for Different Sectors
EventStudy
To examine the financial impact of new information in the market, we used event study as our methodology. Assuming efficient markets, new information should be reflected in the price of individual securities, and, by extension, changes in the quality of valuable disclosure should have an impact on firm market value. Using daily returns for each firm would allow us to investigate the presence of returns not explained by expected return models in the days around the annual report release, thus isolating the financial effect of changes in strategy disclosure.
0 100 000 200 000 300 000 400 000 500 000 600 000 700 000 800 000
Energy Banking FMCG Commodities Telecom Seafood Industry Finance IT Real Estate Shipping Airline industry Health Biotech
Market value (mNOK)
23 A Brief Introduction: Event Study
The event study methodology has played an important part in corporate finance literature in recent decades, attempting to examine the isolated effect of corporate events on different dimensions of firm performance. Since its widespread
introduction by Fama, Fisher, Jensen and Roll (FFJR) (1969), event studies have served as the main measurement tool for security price reactions to corporate events, news, announcements, or happenings (Binder, 1998; Brown & Warner, 1985; Eckbo, 2008). The methodology is based on the efficient market hypothesis and assumes that all available information will be reflected in the price of a security. Thus, any positive or negative reactions to corporate events will be reflected in the abnormal return (AR) – its return in excess of what is expected – of stock i in the period around the announcement date. The event study
methodology will allow the researcher to examine the behavior of returns for firms experiencing a common type of event, and, further, the differing effects of different reactions in the market.
To examine these abnormal returns, one must first calculate the expected return for each individual firm. Several methods have been proposed to measure the rate of normal return for an individual security, with the perhaps most widespread being an equilibrium asset pricing model such as the Capital Asset Pricing Model (CAPM) (Lintner, 1965; Sharpe, 1964), a multifactor model such as the Fama- French Three-Factor Model (Fama & French, 1993), or the Market Model (Brown
& Warner, 1985; Fama et al., 1969). The latter is perhaps considered the most prominent benchmark (Binder, 1998; MacKinlay, 1997), as it represents a less flawed measurement than the CAPM due doubts regarding the validity of the restrictions of the latter, while the marginal gains from a multifactor model are generally quite limited with regards to the explanatory power of the model (MacKinlay, 1997). In the Market Model, the return of an individual security is not only dependent on the return of the market portfolio, but also on the
idiosyncratic risk of that same security.
If the Market Model is chosen as the benchmark for expected returns, the next step is to decide the estimation window. This is the trading data that will be used to estimate the relationship between the market portfolio and each individual security. When daily returns are used, estimation periods are often recommended
24 to be between 100 and 250 days (Cox & Peterson, 1994; MacKinlay, 1997;
Sorokina et al., 2013), but this is still debated. Further, one must decide the event period, in which the event is presumed to affect the daily returns of the individual securities. Even here the standard window is debated, and academia has not yet found consensus around a golden standard with regards to the trade-off between results and validity. While studies have recommended an event window ranging from ±1 days to ±10 days for daily return studies (MacKinlay, 1997), studies have used event windows as large as 181 trading days (McWilliams & Siegel, 1997). It is also important to consider the nature of the event, as the chosen event window should be contingent on the circumstances, such as the event itself and the subsequent relationship that is being measured.
After a model for the expected return has been chosen, and it has been calculated with the estimation period data for the individual firms, it can be used as a benchmark to measure the abnormal return of firm i for each day, calculated as the difference between the expected and actual return of firm i each day in the event period. The common practice is then to aggregate the individual abnormal returns across the firms, dividing the set into e.g. positive and negative reactions in the market, finding data on the average abnormal return (AAR) for the different groups. Further, to see the total effects, the sample average abnormal returns are summed across the event period to form the sample cumulative average abnormal return (CAAR) across securities. This latter construct will allow the researcher to investigate the differing aggregate effects on the abnormal returns from different reactions in the market, and thus the economic effects of the event studied.
Data:
We define the event date as the release date of the annual report, or, in the case where it was released after stock market closing, the next trading day. This way, we can examine the abnormal returns for the actual trading day relevant to the release, reducing bias across the data. Using the 490 annual reports in our full set for our content analysis, we removed all firms where the release date of the annual report was not available. Additionally, following McWilliams and Siegel (1997), we excluded firms that had released relevant statements or reports on the event day to reduce potential bias in returns. After the data set was cleared, we were left
25 with N = 455 rated firm-years. We proceeded to retrieve trading data for each security and the Oslo Stock Exchange from Thomson Reuters Eikon. For each individual firm, we gathered daily returns for an estimation period of T = 150 days (t-160 to t-10 days for the release date of the annual report) for the years 2011- 2015 to estimate the expected returns. We further decided on a ±10-day event period, which is perhaps somewhat longer than usual for daily return studies. The reason for our choice is the qualitative nature of the strategy disclosure scores;
any changes or “shocks” related to investor expectations will not be discernible immediately, but rather be understood over an extended period when the investor studies the released annual report. Moreover, it would seem plausible that
leakages of information could occur in the days leading up to the actual release, providing a rationale for including a 10-day window pre-event as well
(McWilliams & Siegel, 1997).
Expected Returns:
Following the seminal studies of FFJR (1969) and Brown and Warner (1985), we estimated the expected returns using the Market Model, regressing the actual returns of firm i on the returns of the market portfolio for each individual firm. In order to find the relationship between the returns of individual securities and the corresponding return of the market portfolio, we used ordinary least squares (OLS) to estimate the market model parameters by regressing the returns of the stock against the return of the market index for each day in the estimation window:
𝐸(𝑅𝑖,𝑡) = 𝛼 + 𝛽 ∙ 𝐸(𝑅𝑀,𝑡)
where 𝐸(𝑅𝑖,𝑡) is the expected return of firm i at time t, and are the parameters of the Market Model estimated from regressing 𝑅𝑖,𝑡 on 𝑅𝑀,𝑡 over the estimation period T, and 𝐸(𝑅𝑀,𝑡) is the expected return of the market index at time t. We used an estimation period of T = 150 trading days leading up to the event for the individual security, including a 10 day suspension before the actual release date to circumvent any potential bias arising from overlapping the estimation period with the actual event period, as this would result in disturbances that are not mean zero (Binder, 1998; Brown & Warner, 1985). We assumed that returns more than 10
26 days prior to the event day did not interfere with the estimated parameters and
, such that any returns in the event window should be unbiased. This provided us with the benchmark needed to compute the abnormal returns for the individual firms.
Abnormal Returns:
The abnormal returns for the individual securities was calculated as the actual return for firm i less its expected return from the Market Model the same day for each point in time t in the estimation period:
𝐴𝑅𝑖,𝑡 = 𝑅𝑖,𝑡− 𝐸(𝑅𝑖,𝑡)
where 𝑅𝑖,𝑡 and 𝐸(𝑅𝑖,𝑡) is the actual and expected return of firm i at time t, respectively, and 𝐴𝑅𝑖,𝑡 is the abnormal return of the associated firm.
Average Abnormal Returns and Cumulative Average Abnormal Returns:
After the data had been grouped, abnormal returns for the different groups were aggregated to find the average abnormal returns (AAR) for positive and negative surprises:
𝐴𝐴𝑅𝑡 = 1
𝑁∑ 𝐴𝑅𝑖,𝑡
𝑁
𝑖=1
The estimates of the average abnormal returns were then used to estimate the cumulative average abnormal returns (CAAR) across the sample securities in the different groups:
𝐶𝐴𝐴𝑅𝑡= ∑ 𝐴𝐴𝑅𝑡
𝑇
𝑡=1
These constructs would then allow us to investigate the influences on the daily returns from different reactions in the market. Specifically, it would show the differing cumulative effects on abnormal return for firms that surprised investors
27 in either a positive or negative manner, and thus provide indications to the
potential economic effects of strategy disclosure.
Grouping Observations on the Event Date
In order to look for an effect between disclosure and abnormal returns, we needed to group our sample into performers and non-performers (MacKinlay, 1997). As supported by the efficient market hypothesis, disclosure per se will not lead to abnormal returns, but instead we need to look for changes that surprise the market by providing new information. To look for these positive and negative surprises or
“shocks”, we tested the relative changes from strategy disclosure quality as formed by the investors’ expectations. For 2015 changes we used the average of 2011-2014 scores to form the investor expectations for a given firm, and,
correspondingly, the 2011-2013 average to test for changes in 2014, giving N = 182. This would allow us to place the firms into groups of either positive or negative “shocks”, and, subsequently, test for the differing effects on abnormal returns for the groups from relative changes. In order to clearly distinguish between positive and negative surprises, we created three categories; the top 25%
and bottom 25% in values of change from expectations, and the remaining 50% of the sample, representing positive, negative, and negligible surprises for strategy disclosure, respectively. The technique of grouping firms and looking at cross sectional abnormal returns is widely used in the literature (e.g; Fama et al., 1969;
Leuz & Verrecchia, 2000). Since we wanted to examine changes in the actual quality of disclosure, we did not use a dichotomous rating scheme. Here, observations on the periphery of a group could be practically indistinguishable from an adjacent observation in the next group. To deal with this issue, we thus created a group structure with significant distance in changes of quality between the positive and negative surprise groups. After dividing the observations into the top- and bottom 25% groups, as well as the remaining 50%, we could examine the abnormal return for each firm in the period around its annual report release date.
Subsequently, we could construct the AAR and CAAR for the positive and negative groups, allowing us to investigate the differing financial effects of the changes in strategy disclosure.
28 Further, our data would also allow us to examine the financial effects of
individual strategy dimensions, to better understand any specific drivers of abnormal returns. These, however, were not grouped by the top and bottom 25%, as our N for single dimensions was substantially reduced due to low year over year changes for individual dimensions.
Strategy Disclosure
To construct our measure of strategy disclosure to use in the event study, we employed content analysis of firms’ annual reports. As no ranking or index of strategy disclosure quality for Norwegian listed firms exists, content analysis represented an appropriate methodology to score individual strategic dimensions argued to be of informational value in annual reports, and, ultimately, establish our independent variable strategy disclosure.
A Brief Introduction: Content Analysis.
As defined by Neuendorf (2002, p. 1), content analysis is; “…the systematic, objective, quantitative analysis of message characteristics,”. Further, Habermas (1987) states that “…we need to note that communicative action rest at the very base of the lifeworld, and one very important way of coming to grips with that world is to study the content of what people say and write in the course of their everyday life,” (Habermas, 1987, p. 80). On the other hand, where methods borrowed from the natural sciences have been applied, social researchers prevent themselves from addressing what matters most in everyday social life; human communication, commitments people make to each other and to the conception of society they aspire to, what they know, and why they act (Krippendorff, 2004, p.
11). Certainly, content analysis is not the only research method that seeks to capture what is mediated between people, texts, information, symbols so forth, but it has developed over the years into one of the strongest tools for interpreting communication.
To make valid inferences from text, it is important that the classification
procedure is reliable in the sense of being consistent; different individuals should code the same text in the same way (Weber, 1990, p. 12). For our research, we were three coders, so in order to limit any bias that might arise from differences between us, routines to control reliability is important. Classification by multiple
